Trends and Determinants of Foreign

Direct Investment in India: A Study

of the Post-liberalization Period

Reenu** and Anil Kumar Sharma**

Foreign Direct Investment (FDI) is a pivotal instrument for economic development and bridging
the gap between developed and developing nations. Rising economies grant special incentives
to attract FDI and empirical literature is replete with studies on the determinants of FDI
inflows in India. In this paper, we have identified trends of FDI inflows, made a framework
o f pre-revised and post-revised FDI regimes and identified relevant determinants of FDI in
India by employing an Ordinary Least Square Regression (OLSR) analysis. Data from August
1991 to February 2014 has been used for identifying trends and policies for FDI inflows and
the annual series from 1991 to 2010 has been used for calculating the determinants of FDI
inflows. In this study, FDI inflows are modeled as a function of market size, openness,
infrastructure (electricity), interest rate and inflation. Results show that market size and
infrastructure are major factors that have a positive and significant effect on FDI inflows.
This paper suggests ways to make India’s economic policies more effective for increasing
inflows for developing infrastructure. A successful FDI policy must be well integrated with
liberalization, privatization and globalization policies.

K ey Words: Foreign Direct Investment, India, Policy, Trend, Determinants

INTRODUCTION
India makes an increasingly significant use of Foreign Direct Investment (FDI), which
works as a volatile source of finance (Moosa and Cardak, 2005) in different sectors such
as infrastructure, telecommunication, power, insurance, airports, road modernization
for the improvement of these sectors. For this reason, foreign investors want to know
which sectors are more attracted to FDI and what kind of policies are followed by these
sectors. However, some sectors (pharmaceuticals, agriculture and airlines services) have
* Research Scholar, Department of Management Studies, Indian Institute of Technology Roorkee, Roorkee
247667, Uttarakhand. E-mail: kmreenul985@gmail.com
** Associate Professor, Department of Management Studies, Indian Institute of Technology Roorkee, Roorkee
247667, Uttarakhand. E-mail: aanilkssharma@gmail.com
 TRENDS AND DETERMINANTS OF FOREIGN DIRECT INVESTMENT IN INDIA:
A STUDY OF THE POST-LIBERALIZATION PERIOD

not yet taken full benefits of FDI inflows (i.e., new technology, promote production,
high rate of return and new opportunities). According to World Investment Report
(2002) 208 changes related to FDI policies have been made by 71 countries in 2001.
These changes have proved favorable for the foreign investors and domestic investors.
Past studies (Moosa and Cardak, 2006; Schneider and Frey, 1985; and Gastanaga,
Nugent and Pashamova, 1998) were generally considerate about the determinants of
FDI, which are domestic market size, trade openness, labor cost, wage rate, exchange
rate and infrastructure. Most of the studies focused on the cross and panel data sample
for the determinants of FDI in the case of developing countries (See, Gastanaga,
Nugent and Pashamova, 1998; Globerman and Shapiro, 2002; and Vadlamannati et
al, 2009). On the other hand, only few studies (Zheng, 2009; Azam and Lukman,
2010; Dhingra and Sidhu, 2011) have actually acknowledged the policies (pre-revised
and post- revised) and trend of FDI inflow. With regard to combined research on
policies, trend, and determinants of FDI in India exists an even more famine literature.
So that, objective of our paper is to fill this research gap by highlight FDI policy
changes, identify FDI trends, and analyze the main relevant determinants of FDI in
India. A large number of studies (Jajri, 2009; Awan, Zaman and Khan, 2010; Amal,
Tobio and Raboch 2010; Tosompark and Daly, 2010) has been conducted in different
countries (Pakistan, Latin America, Thailand, Malaysia, Jordan, Italian) but India
still needs to have a vigorous discussion about current changes in FDI polices, trend,
and its relevant determinants because India’s relatively GDP growth is high instead of
other developing countries which directly contribute to the world economic growth.
This study provides worthy evidence related to policies (pre and post revised) and
trend of FDI (Year wise, route wise, country wise, sector wise, state wise and region
wise). O n the other hand, to examine the determinants of FDI and in this context,
the time series properties of the data over the period 1991-2010 are meticulously
examined. Additionally, this time series analysis with help of ordinary least square
method after checked all the time series properties which were ignored in the existing
empirical work.
This paper is organized as follows: Section II presents a framework of FDI Policy in
India. Section III discusses the trends of FDI inflows. Section IV provides a literature
review on the determinants of FDI inflows and its distributions on a conceptual and
empirical basis. Section V describes the prudence behind the variables selected for
the methodology and the empirical outcome are furnished in section VI. The policy
implications are made in Section VII along with the limitations and conclusion.

FDI POLICY FRAMEWORK IN INDIA

Policy plays an imperative role in the FDI inflows in India. According to the worldwide
ground rules, the capability of a country to attract FDI depends upon its government
guidelines. This section shows a review and comparison of India’s FDI policy structure
before liberalization and after liberalization (see Table 1).

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Table 1: Phase-wise Industrial Policies in India

P hase Year Policy D escrip tio n
Phase I 1948- Industrial • Foreign ownership was only allowed up to 40% of the total
1968 Policy 1948
equity capital. No huge am ount was allowed before 1991.

• More qualified outlook towards FDI in the late 1960’s as

home industries developed.

• Industrial Policy Resolutions were announced in 1956,1980,

1990 and 1991. There are so many changes in this revolution
explain in continual.
Phase II 1969 - MRTP A ct • T he Monopolies and Restrictive Trade Practices Commission
1991 (1969) (MRTP) in 1969, which obligatory boundaries on the range
of operatio n s, p ro d u cts prices an d services of foreign
companies.

FERA • In 1973, the new Foreign Exchange Regulation A ct (FERA)

(1973) O r came into force, requiring all foreign companies operating in
FEMA India to register under Indian corporate legislation with up
(1999) to 40% equity this limit could be raised to 74% after some
time.

• In the 1980s, as a part of the industrial policy resolution, the

attitude towards FDI was liberalized and Identification of
high priority in d u stry (including 33 industry)- D irect
investm ent up to 74 % and 100% was authorized in the
priority sector and sell to oth er countries oriented units
correspondingly with full repatriation benefits.

• Foreign in v estm en t an d te ch n ic al co llab o ratio n were

welcomed.

Phase III 1991- Liberalization • In 1991 current account deficit to go up to 3.2% of GDP
1999 of Industrial which were caused by partial loss of export market in West
policies Asia, increase in POL imports and slow down of remittances
from non-resident Indians.

* In 1991, India Introduce m arket oriented reforms, which

was liberalised new FDI policy and it was package of
encompassing industry policy, trade policy, financial sector
policy and exchange rate policy.

• A fter liberalization Policy was changed towards foreign

in v e stm e n t - b o th foreign in v e stm e n t an d p o rtfo lio
investment after that new institution were set up to facilitates
the flow of FDI.

• In 1996, th e a u to m a tic ap p ro v al ro u te for FD I was

lengthened, from 35 to 111 industries; fewer than make four

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Table 1 (Cont.)
P h ase Year Policy D esc rip tio n

distinct categories (Part A-equal to 50%, Part B-equal to

51%, Part C-equal to 74%, and Part D-equal to 100 %.)

Phase IV 2000- Globalization • India change tracks after globalization and embarked on a
2009 era broader development of reforms deliberate to increase her
combination with the universal economy. Import quotas were
fully removed. T he Government has relaxed in ownership
restriction, foreign ownership was raised from 49 to 74% in
telecom and utilities sector banks (in 2001). After th at FDI
up to 100% were allowed on automatic routes in most sectors’
and activities except few sectors'

Phase V 2010 Consolidated • T he consolidated docum entation starts from 2010 for the
documentation m aintenance of validation practice and accessible regulations
on FDI. In this consolidated FDI policy all the policy and
paper work combined in single docum ent1.

Phase VI 2010- Retail sector, • Conclusion of all these changes now India has the largest
till date Insurance, part striking FDI Polices in whole Asia region.
Infrastructure

Note: 1: DIPP (2014), Factsheet and Table G.

Source: Government of India (2006), U N C T A D (1996,2003,2011), SIA Newsletter, March 2014

Major changes were effected in India’s economic policy in 1991 with the main
objective of promoting economic growth and integrating Indian economy with the
world economy. Industrial policy reforms have been reduced all restrictions to the
investment projects and tried to enlarge all business activities and admittance to foreign
equipment and financial support. A sequence of procedures were bound towards dealing
with liberalizing overseas: (i) Prologue of a twofold route of endorsement of FDI—
Reserve Bank of India (RBI)’s automatic route and Government’s approval (SIA/
FIPB) route; (ii) Permission for Non-Resident Indians (NRIs) and Overseas Corporate
Bodies (OCBs) to own up to 50% of high priority sectors; (iii) Investment proposals
falling under the automatic and government routes.
The automatic route required no prior permission from government bodies, except
for informing the RBI within 30 days. Investors are obligatory to report the concerned
regional office of the RBI about the new investment proposal. The government route
requires prior permission from the government. The government handles investments
and FDI issues with the assistance of three institutions, the Foreign Direct Investment
Promotion Board (FIPB), the Secretariat for Industrial Assistance (SIA) and Foreign
Investment Implementation Authority (FIIA). The pre-revision policy and post-revision
policy in requisites of the sector precise limits are summarized in Table 2. The
Department of Industrial Policy and Promotion (DIPP) has unconfined the Consolidated
FDI Policy for 2014. It is effective as of April 17, 2014. There is not anything latest for
the various sectors. FDI caps in the subsequent sectors have been unscathed in 2001:
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defense (26% FDI, cap and changes are anticipated for circumstances of the art
technology), airports (74% cap via government route), publish media (26% FDI cap),

Table 2: FDI-Permissible Limits U nder D ifferent Policy Regimes

Before Revised Policy
A fter Revised Policy (after 2013)
(till 2013)
Sector
Investment A pproval Total Changes in Investm ent Caps
cap R oute and A pproval R outes
Agriculture and 100% G overnm ent 100% investment caps by automatic routes.
Animal Husbandry

Tea Plantations 100% Governm ent 100% investm ent caps allowed by government
routes but not allowed in other plantation sectors/
activity.
Civil Aviation Sector 26% G overnm ent Varies from different sectors like

• Greenfield project 100% caps by automatic

• Brownfield project 100% caps by automatic
Goods Exchange 49% G overnm ent No change in caps and Only route has been
changed government to automatic.
Power Exchange 49 Government No change in caps and Only route has been
changed government to automatic.
Stock Exchange, 49% G overnm ent No change in caps and Only route has been
Depositories, changed government to automatic.
Clearing Corporation

Assets Construction 74% G overnm ent Changes in autom atic routes up to 49% and
government routes allowed 49% to 100%.
Telecom Services 74% A utom atic No change in automatic routes cap but canceled
government routes which was allowed 74%.
Courier Services 100% Governm ent No change in caps but changes in routes.
Test Marketing 100% Governm ent No change in caps but changes in routes.
Petroleum Refining 49% Governm ent No change in caps but changes in routes.
by Public Sector
U ndertakings

Defense Production 26% Governm ent N o change in caps by autom atic routes but
governm ent also allowed above 26% through
government.
Single Retail Trading 100% Governm ent Government divided caps in two routes up to
Investm ent 49% allowed by automatic and 100% allowed
by government.
Infrastructure Varies in G overnm ent/ 100% allo w ed in in fra s tr u c tu re th ro u g h
different A utom atic automatic.
sectors
Source: D1PP (2014), S1A, Various issues

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 TRENDS AND DETERMINANTS OF FOREIGN DIRECT INVESTMENT IN INDIA:
A STUDY OF THE POST-LIBERALIZATION PERIOD

Brownfield Pharmaceuticals (100% FDI cap, only passing through government route)
multi-brand retail (51%, only using government route).

GROWTH OF FDI INFLOWS IN INDIA

India has undergone significant changes after attracting considerable amounts of FDI
inflow and outflow since economic reforms in 1991. The trend is to depend upon
various parameters to a larger extant and carefully provide a host country government.
TRENDS IN FDI INFLOWS TO INDIA
After the liberalization of India’s foreign investment policy, FDI inflows have shown
an upward trend in stock but have fluctuated in size over time. From 1991-1992, FDI
inflows were estimated at $129 mn. This amount gradually increased till 1999 when it
reached up to $2155 million. FDI reached an apex of $4065 mn in 2002 before declining
in the years 2003 and 2004- The year wise calculated Compound Annual Growth
Rate (CAGR) in India along with FDI inflows from 1991-1992 and 2013-2014 are
shown in Figure 1 and 2. In the terms of CAGR, the growth rate of FDI inflows to
India declined from 180% in 1992-1993 to 30.9% in 1997-1998. During this period,
the growth rate was positive, but turned negative from 1998 to 2000. This happened
again from 2001 to 2003 but after globalization, the growth rates were negative for
consecutive three times in the years 2009-2010, 2010-2011, and 2012-2013.

Figure 1: FDI Inflows from 1991-92 to 2013-14

(2013 - only from April to October)

40000
35000 ■

30000
25000
FDI Inflow (Amount in USS m illion) / \
20000
15000
10000
5000
0

^ ^ ^ ^ ^ ^ ^ ^ ^ ^ S’ ^ ^

Source: SIA , Various issues

ROUTE WISE FDI INFLOWS/ REVISED FDI INFLOWS

The RBI and SIA, Ministry of Commerce and Industry monitor FDI statistics and
publish the official reports on FDI trends and statistics in India. In the balance of
payments records, while RBI compiled all data on FDI statistics prior to 2000, it only
included the equity capital. The IMF’s classification of FDI incorporates equity capital,
reinvested earning, and other direct investments. This type of government policy leads
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to a paradox of FDI inflows. The book keeping scheme of FDI inflows was revised in
2000 as per the global best practices.

T ab le 3 : R o u te -w is e / R e v ise d F D I In flo w s fro m 1 9 9 1 to 2 0 1 4

( A m o u n t in U S $ m n )
Year 1 2 3 4 5 6 = ( l + 2 + 3 + 4 + 5)
1991-92 129 129 - - - 258
1992-93 315 315 - - - 630
1993-94 586 586 - - - 1172
1994-95 1314 1314 - - - 2628
1995-96 2144 2144 - - - 4288
1996-97 2821 2821 - - - 5642
1997-98 3,557 3,557 - - - 7114
1998-99 2,462 2,462 - - - 4924
1999-00 2,155 2,155 - - - 4310
2000-01 2,400 2,339 61 1,350 279 6,429
2001-02 4,095 3,904 191 1,645 390 10,225
2002-03 2,764 2,574 190 1,833 438 7,799
2003-04 2,229 2,197 32 1,460 633 6,551
2004-05 3,778 3,250 528 1,904 369 9,829
2005-06 5,975 5,540 435 2,760 226 14,936
2006-07 16,481 15,585 896 5,828 517 39,307
2007-08 26,864 24,573 2,291 7,679 300 61,707

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Table 3 (Cont.)
Year 1 2 3 4 5 6 = (l + 2 + 3+ 4 + 5 )
2008-09 32,066 31,364 702 9,030 777 73,939
2009-10 27,146 25,606 1,540 8,668 1,931 64,891
2010-11 22,250 21,376 874 11,939 658 57,097
2011-12 35,855 34,833 1,022 8,206 2,495 82,411
2012-13 22,884 21,825 1,059 11,025 2,951 59,744

2013-14 13,121 12,603 518 4,937 876 18,934

(A p r-
O ct, 2013)

Grand 233391 223052 10339 78264 12840 5 4 4 ,7 6 5

Total
Note: 1 stands for - by equity, 2 stands for - by FIPB Route/RBI’s automatic route, 3 stands for - by equity capital
(unincorporated bodies), 4 stands for - by reinvested earning, 5 stands for - other capital and 6 stands for
- total.
Source: RBI, Various issues

In India, there are two main channels for FDI equity inflows, one is the Secretariat
for Industrial Assistance (SIA/ FIPB) route and the other is the automatic approval
route of RBI. From the commencement of these channels in 1991 until 2000, the
majority of the FDI inflows to India entered through the government route because
approvals were strictly monitored. Through the routes of RBI, FDI inflows are more
than government route (see Table 3). However, FDI inflows have fluctuated in the
past five years. The RBI route is more positive leading to a spurt of FDI. In 1991, as
much as $129 mn of the total FDI came through the SIA/ FIPB route. There were no
inflows for equity capital of union/corporate bodies, reinvested earnings and other
capital. There were more fluctuations of route FDI inflows until 1998. In 2000-2001,
FDI came through different channels like equity inflows unincorporated bodies,
reinvested earnings and other capital. The total equity inflows have been divided
into two parts: FIPB route and RBI’s automatic acquisition route. The association of
both FIPB route and RBI’s automatic acquisition route was more powerful and attracted
a higher amount of FDI inflows. Before 2000 to 2001 and the latest data related to
routes of FDI inflows from 2013 to 2014 indicate that the FIPB route and RBI’s automatic
route continues to dominate. The FIPB Route and RBI’s automatic acquisition route
have an imperative element and their implication has increased approximately
persistently over the period. The total FDI inflow was $223 mn in India through FIPB
Route and RBI’s automatic acquisition route for the period from 1991-1992 to 2013—
2014. The second highest FDI inflow was $78,264 mn from the reinvested earnings
followed by other capital routes. The lowest FDI inflow was $10 mn from the equity
capital of unincorporated bodies. Apart from the routes that may facilitate FDI in any
economy, the foreign investor must also evaluate country wise inflow of FDI.

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COUNTRY WISE FDI INFLOWS TO INDIA

Table 4 reveals that top 10 countries which is invested in India since 1991 to 2014.
FDI inflows in India are supported by different countries like Mauritius, Singapore,
UK, Japan, USA, Netherlands, Cyprus, Germany, UAE and France. Between 2000
and 2014, Mauritius and Singapore were the main contributors of FDI inflows to India.

Table 4: Top Ten FDI Investing Countries from 1991 to 2014 (US$ in millions)
%age to Total Inflows
R ank C ountry C um ulative Inflows
(in term s of US$)
1 Mauritius 76,765 37%
2 Singapore 22,325 11%
3 UK 19,442 9%
4 Japan 15,011 7%
5 U SA 11,656 6%
6 N etherlands 10,050 5%
7 Cyprus 7,207 4%
8 Germany 6,094 3%
9 France 3,746 2%
10 UAE 2,616 1%
Total FDI inflows from all countries* 206,006 -

Source: S1A, Various issues

Figure 3: Top Ten Investing Countries (FDI Equity Inflows)

■ MAURITIUS
■ SINGAPORE
■ U.K
■ JAPAN
■ U.S.A
■NETHERLANDS
■ CYPRUS
■GERMANY
■ FRANCE
■ U.A.E

Source: SIA, Various issues

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Figure 3 shows Mauritius as the largest foreign direct investor in India. Mauritius
has a low rate of taxation and avoids having a double tax regime. Singapore is the
second biggest financier in India. The total amount of capital inflow from Singapore
was approximately $22 mn from 2000 to 2014, which accounted for 11% of the whole
FDI inflows. The UK and Japan are India’s third and fourth major source of FDI
inflows. The funds from these countries concentrate only on weak areas in India such
as power or energy, telecom, and transportation sector. The US was the second leading
source of growing FDI inflows in India in 1991’s, but has decreased during this time
period.
SECTORAL DISTRIBUTION OF FDI IN INDIA
Table 5 presents the ranks, names, and shares of FDI inflows for the top ten sectors, as
reported in SIA publications. This table shows the share of FDI inflows for two collective
periods, and the recent information for the year 2012 is not available. During the first
cumulative period from August 1991 to December 1999, amongst the ten main sectors,
transportation industry was the highest attractive sector to draw huge FDI inflows,
and the percentage of total FDI Inflows was 8.9% in terms of US$, whereas during the
second cumulative period, from April 2000 to October 2013, the scenario totally change
in terms of foreign investors interest and the FDI policy also changed so that, the
service sector become the most attractive sector for the investors with 19% share. But
from April 2013 to February 2014, the food processing took the first place for the
investment purpose with 18.17% share of the total FDI inflows (see Table 5). The
appearance of the service sector is clear from the association of the shares over the
two periods and one single current year. In the globalization period, many new sectors
entered the record of the top ten recipient sectors. They are building activities, housing
and properties, computer hardware and software. The varying impact of the top ten
sectors is shown in Figures 4, 5, and 6.

Table 5: Sector-Wise Break-up of FDI as Percentage

of Total Investment (Aug 1991 - Feb 2014)
Ten Sectors (Share as % to total inflows in terms of US $)
S ector % age to S ector (April, % age A pril, 2013 % age
R ank (Aug 1991-Dec Total 2000 to O ctober, to Total to February, to Total
1999) Inflows 2013) Inflows 2014 Inflows
1 Transportation 8.9 Service sector 19 Food processing 18.17
industry industries
2 Electrical 8 Construction 11 Services sector 10.51
Equipm ent Development:
(including S/W Township, Housing,
& Elec) Built -UP
Infrastructure

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Table 5 (Cont.)
S ector % age to S ector (April, % age A pril, 2013 % age
R ank (Aug 1991-Dec Total 2000 to O ctober, to Total to February, to Total
1999) Inflow s 2013) Inflow s 2014 Inflows
3 Service sector 7 Telecom munication 6 Automobile 6.18
(radio paging, industry
cellular mobile,
basic telephone
service)
4 Tele^ 6.9 Com puter software 6 Drugs and 6.12
com munications & Hardware pharmaceuticals
5 Chemicals (other 6.9 Drugs & 6 Com puter 5.2
than fertilizers) Pharmaceuticals software and
hardware
6 Fuels (Power & 6.3 Chemical (other 5 Construction 5.06
Oil Refinery) than fertilizers) development:
Township,
Housing,
Built 'U P
Infrastructure
7 Food'Processing 4.1 Automobile 4 Power 4.45
industries industry
8 Paper and Pulp 1.5 Power 4 Ferm entation 3.91
(including Paper industries
Products )
9 Miscellaneous 1.4 Metallurgical 4 Hospital and 3.17
M echanical and industries diagnostic
Engineering centers

10 Textiles 1.4 H otel & Tourism 3 Trading 3.04

(including Dyed,
Printed)
Source: SIA, Various issues

Figure 5 shows the service sector as the most attractive sector for FDI inflows from
2000 to 2013. Considering broadly, the service sector includes computer software,
trading, transport, hotel, tourism, information and broadcasting, telecommunication,
housing and real estate, construction, and consultancy services, and the total FDI
inflow was only 44% in the 1990’s. This share increased to 60% from 2000 to 2011.
Most FDI inflows are attracted to power utilities, real estate, computer, financial, and
communications and these are included in the service sector. The second most
attractive sector is construction, which constituted around 11% of the FDI inflows.
The third and fourth most attracted sectors are telecommunications and computer
software and hardware, which also contribute to India’s GDE

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Figure 4: Ten Sectors Attracting High FDI Inflow in India

(April 1991 to Oct 1999)

■ Transportation industry
4.10% 1.50%. 4QO/
■ Electrical Equipment
(including S/W & Elec)
■ Service sector

■ Telecommunications

■ Chemicals (other than

fertilizers)
■ Fuels (Power & Oil
Refinery)
■ Food-Processing industries

■ Paper and Pulp (including

Paper Products)
■ Miscellaneous Mechanical
& Engineering
■ Textiles (including
Dyed, Printed)

Source: SIA, Various issues

Figure 5: Ten Sectors Attracting High FDI Inflow in India

(April 2000 to Oct 2013)

■ Service sector

■ Construction Development:
Township, Housing, B uilt-U P
Infrastructure
■ Telecommunication (radio
paging, cellular mobile, basic
telephone service)
■ Computer software &
Hardware

■ Drugs & Pharmaceuticals

■ Chemical (other than

fertilizers)

■ Automobile industry

■ Power

■ Metallurgical industries

Source: SIA, Various issues

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Figure 6: Sector Attracting High Inflow of FDI in India

during in April 2013 to Oct 2014
■ Food processing industries

■ Services sector

■ Autom obile industry

■ Drugs & pharmaceuticals

■ C om puter softw are &

hardware

■ Construction developm ent:

Township, Housing, B u ilt-
UP Infrastructure
■ Power

■ Ferm entation industries

■ Hospital & diagnostic

centers
6 . 18%
■ Trading

Source: SI A , Various issues

REGIONAL/STATE-WISE DISTRIBUTION OF FDI INFLOWS TO INDIA

The regional distribution of FDI inflows in India is one of the most prominent indicators.
The local business investment climate for FDI in India has changed resulting in strong
implications for the state policy makers. FDI inflows show a disparity at the regional
level as depicted in Table 6. From 2000 to 2013, a total of 302,632 approvals were
received and were valued at $64,917 mn. Maharashtra ranked first with a share of
32% of the total approved amount of FDI in India followed by Delhi (19%) and Chennai
(6%). O ut of the 16 regions mentioned in the statement on RBI’s regional offices
(with State covered) received FDI equity inflows (DIPL 2014, p. 4). Only four states
are above the average level for the mentioned period, viz., Mumbai, New Delhi,
Chennai, and Bangalore. Additionally, the two states, Guwahati and Patna, had no
inflow of FDI or zero inflow of FDI. The places having small number of approvals are
Bhopal 0.5%, Kochi 0.5%, Panaji 0.4%, Jaipur 0.4%, Kanpur 0.2% and Bhubaneswar
0.2%.
FDI’s are attracted towards more developed states like Mumbai, New Delhi, and
Chennai because of the availability of resources, such as infrastructure, availability of
low cost labor, large markets, and connectively with international countries. Table 6
shows that 10 Indian States received the biggest FDI inflows in 2013 based entirely on
the number of the project reports. Maharashtra received 30% of the FDI inflows and
primarily included Mumbai, Dadra, Nagar Haveli, Daman and Diu. New Delhi

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Table 6: Region /States-Wise FDI Equity Inflows (April 2000 to Oct 2013)
(US$ in mn)
C o llectiv e C o llectiv e
2 0 1 1 -1 2 2 0 1 2 -1 3 2 0 1 3 -1 4 in flo w s in flo w s
R ank S tate (A p ril - (A p r- (A p r to (A p ril (A p ril
M a rc h ) M a rc h ) A ug 2013) 2 0 0 0 to 2 0 0 0 to
A ug 2013) A ug 2013)

1 M ah arash tra 9553 8716 1580 64917 32%

2 D elhi 7983 3222 1075 37369 18%

3 Tamil N adu 1422 2807 1078 12158 6%

4 K a rn a ta k a 1533 1023 738 11523 6%

5 G ujarat 1001 493 358 9032 4%

6 A n d h ra Pradesh 848 1,159 358 8325 4%

7 W est Bengal 394 424 124 2430 1%

8 C h a n d ig a rh 130 47 22 1223 1%

9 M adhya Pradesh 123 220 116 1113 0.60%

10 K arala 471 72 48 959 0.50%

11 A ll others 11663 4240 7106 56957 26.90%

(rem aining 11-16)2

T otal 3 5 ,1 2 1 2 2 ,4 2 3 1 2 ,6 0 3 2 ,0 6 ,0 0 6 100

Note: 2 See fact sheet of foreign direct investment, 2014 and table no G.
Source: S1A, Various issues

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 SOUTH ASIAN JOURNAL OF MANAGEMENT

attracted 19% of FDI inflows in transportation, telecom munication, electrical

equipment, and services and primarily included Delhi, Part of UP and Haryana. Chennai
including Tamil Nadu and Pondicherry attracted 6% of FDI inflows for its advanced
automotive components, Ford and Hyundai, which made major investments in these
states. Bangalore including Karnataka attracted 4% of the total received FDI for
huge projects in technology, software, hardware and computer components.
According to Figure 7, Maharashtra (Mumbai) and New Delhi have been the top
player in India. Karnataka, Tamil Nadu, Gujarat, West Bengal, Chandigarh, Andhra
Pradesh, Madhya Pradesh and Kerala have also drawn major shares of FDI inflows.
For descriptive goal, India’s Department of Industrial Policy and Promotion (DIPP)
divides the country into 16 local offices. The apex 10 local offices have been promoting
greater than two-thirds of all FDI inflows from April 2000 to October 2013 (Table 6).
The geographical spread of FDI depends upon the FDI policy of the host country
government to a significant extent.

LITERATURE REVIEW
CONCEPTUAL EVIDENCE
There are several theories that have attempted to explain the factors of foreign direct
investment. These theories help to make a framework of how foreign direct investment
comes to home countries from host countries vice -versa. The most famous and important
theory of FDI was given by Dunning (1973) who reported that when a firm evolves
from domestic to a MNC, it gains three types benefits ownership, location, and
internationalization advantages. Various scholars have been studying the different
categories of FDI (i.e., horizontal plus vertical FDI). Most of the studies discuss the
determinants of FDI in the rising countries and the location advantages emphasized
by Dunning. Ownership and location are required to be included as a determinant of
FDI from the prospective of developing countries.
Dunning (1973) studied econometric models using a statistical analysis of surveys
on the determinants of FDI. His analysis defines the determinants of FDI in a particular
location, market force (including market size, growth as a gross domestic product and
per capital income in the host country), cost factors (such as labor cost and availability
and domestic inflation situation) and investment location (balance of payment and
foreign indebtedness) Hymer (1960) tried to find out why firms prefer to go to abroad
and why they choose to invest in a particular location. Stephen Hymer contributed to
the theoretical literature on the determinants of FDI in his dissertation where he
briefly explained the advantages to firms such as managerial skills, marketing skills,
brand name and patented technology. Hymer highlighted the transaction costs and
internalization theories.

Vernon (1966) developed a “product life cycle” hypothesis while explaining the
increase of the US MNC s activities after World War II. This theory has three stages:

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 TRENDS AND DETERMINANTS OF FOREIGN DIRECT INVESTMENT IN INDIA:
A STUDY OF THE POST-LIBERALIZATION PERIOD

growth stage, maturity stage and decline stage. At the time of decline, the main
climax of the product life cycle comes to the home economy because of the motive to
internalize and expand production or services in other countries. This theory developed
out of studying how US firms undertake FDI in other developed and developing
countries. He concluded that the first stage is an investors search for new markets,
which requires flexibility and innovation. In the second stage, investors are required
to produce in other economies without any fear of profit and loss. They enjoy low labor
costs, new technologies and stability. In the third stage of production in the developing
countries, they come under the pressure of loss and lack of new opportunities.
EMPIRICAL EVIDENCE
Several studies have been conducted by scholars, experts and the government, but an
accurate and appropriate list of the determinants of FDI remains elusive. It is very
difficult to maintain a separate list of determinants because there are various types of
determinants, like political, economic, microeconomic, demand and supply variables,
business variables, market efficiencies, push and pull variables. This paper highlights
the empirical studies directed by various economists, researchers and policy makers
on the determinants of FDI in developing countries and others. Khachoo and Khan
(2012) conducted a study to examine the determinants of FDI in 32 developing
countries from 1982 to 2008 using an econometric model. This study considered FDI
inflows as dependent variables, and market size, labor costs, and degree of openness as
independent variables. Their empirical results showed that market size, total reserve,
and infrastructure were positively related to FDI inflows; whereas labor costs were
observed to be negative and significant as predictable.
Scaperlandra and Mauer (1969) emphasized the factors that motivated foreign
investors with respect to US direct investment in the European Economic Community
(EEC) for the period of 1952-1962 by applying the least squares regression technique.
Ekanayak and Korenecki (2011) studied the location determinants of the inward FDI
among the 50 states of the US. The study applied a panel data regression and analysis
using annual data from 1997 to 2007. The real per capita income, education (primary
and secondary enrollment), jobs, research and development expenditure exerted a
positive impact on the inward FDI, whereas, per capita state taxes, real capital
expenditure, scientists, engineers and unemployment rate exerted a negative impact
on FDI. Casi and Resmini (2010) inspected the determinants of FDI in the EU region
and found that the main determinants are GDP growth rate, labor costs, and market
potential. Uwubanmwen and Ajao (2012) used a Vector Error Correlation Model
(VECM) for the explanatory variable (macroeconomic variables), such as exchange
rate, interest rate, inflation, trade openness, real gross domestic product, and
government size of the FDI. The results of the study showed that trade openness,
interest rate, government size, and GDP exerted a positive control on cross border
investments in Nigeria and a negative relationship was found between FDI and
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 SOUTH ASIAN JOURNAL OF MANAGEMENT

exchange rates. Fedderkee and Romm (2006) conducted a study to find out the main
determinants of FDI in South Africa during the period 1956-2003 using a VECM
model. UNCTAD (1999) found that FDI had a negative and positive impact on the
output, but it depends on variables like the terms of trade, black market premiums,
domestic investment ratios, initial per capita GDP education and the state of financial
development. Generally, FDI in manufacturing has positive and significant effects on
the financial growth. This study took data from cross-country FDI flows between 1981
and 1999, and showed that the impact of FDI on economic growth is ambiguous. FDI
in manufacturing generally has a positive effect, but in the service sector, it is ambiguous
(Alfaro, 2003).

The focus of the study is to probe relevant factors that are influencing FDI in
India. This model has been extensively used in the literature and includes various
determinants, such as openness, market size, and human capital, and tax incentives
amongst others. However, no studies have been done in India to recognize the relevant
determinants of FDI. A long list of FDI determinants including supply and demand
variables was depicted in the existing literature (Scaperlanda and Balough, 1983).
Many authors have suggested different determinants, such as market size, growth,
profit rate or deferrals, investment climate in terms of regulation and incentives. The
dependent FDI variables are calculated as the net FDI inflow, which is a percent of
GDP and it is an extensively used measure according to Seethanah and Rojid (2011).
The lack of consensus is because of the difficulty of getting proper data about the
intangible assets like labor costs, labor quality, regulatory climate, etc. Majority of the
studies have inspected the effects of determinants of FDI inflow and found that relevant
determinants include the size of the market, infrastructure, human capital, interest
rate, and openness.

DATA A N D VARIABLES
Annual data was collected for the period from 1991 to 2010, for conducting the study.
The summary of variables is given in the Appendix Table A along with the data source,
proxies, and defined variables. These variables have been used extensively in literature
(Asiedu, 2002; Cheng and Kwan, 2000; Quazi, 2007; Wheeler and Mody, 1992) and
various subsets of the explanatory variables of determinants of FDI have been used. In
1990s, many developing countries have changed the investment scenario because
these developing countries started the process of liberalization and New Economic
Policy (NEP). This is the reason behind choosing the time frame for our study. The
essential data for the selected time period and preferred countries were collected
from World Investm ent Report (2011), World Investm ent Indicator and IMF’s
International Financial Statistics.
DETAILS OF VARIABLES AND METHODOLOGY
These variables are selected based on previous national and international literature.
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 TRENDS AND DETERMINANTS OF FOREIGN DIRECT INVESTMENT IN INDIA:
A STUDY OF THE POST-LIBERALIZATION PERIOD

Dependent variable: Foreign Direct Investment (FDI)

Independent variable: Market size, infrastructure, openness, inflation, interest rate.
The details of the variables used are given below:
Foreign Direct Investment
The net inflows of FDI are investment to obtain a lifelong management interest (10%
or more of the voting stock) in a trade. FDI is mixture of three kinds of investment
that are total sum of equity capital, reinvestment surplus, and other short term and
long term capital recorded in the Balance of Payment (BOP) by the World Bank’s
World Development Indicators (WDI).
Market Size
Market size proxies by GDP or GDP per capital have a significant and positive
relationship with virtually all the studies (Hussain and Kimuli, 2012; Wheeler and
Mody, 1992). Market size is attracting the foreign investors for FDI inflows according
to the literature because it is a relevant determinant of FDI in India. A large market size
attracts foreign investors, which is why economies try to expand the market size based
on an efficient scale of production or consumable goods and services.
Hypothesis 1: The large market size attracts higher amount of FDI.
Infrastructure
According to Singhania and Gupta (2011), infrastructure is considered a proxy of electric
power consumption. Electricity is particularly important for FDI inflows in India because
it is a vital instrument for economic growth. Infrastructure growth is taken as the evidence
of FDI inflows as is seen in previous studies (Wheeler and Mody, 1992; Kumar, 1994;
Asiedu, 2002; Tsen, 2005).
Hypothesis 2: The improved infrastructure in any economy causes the higher inflow
of FDI.
Openness
Openness refers to the trade openness that includes annual total exports and total
imports divided by gross domestic capital (see Cleeve, 2008; Botric and Skuflia, 2006).
Export represents the worth of all other goods and services, which include the value of
stock, shipping costs, license fees, royalties, insurance, transport, travel, and other services,
such as communication, production, information, enterprise, private, and direction
services. They exclude employee reimbursement, investment revenue, transferable
expenditure, importation of commodities; services’ correspond to the price of all other
goods and market services.
Hypothesis 3: More openness in the host country will invite more FDI from the home to
host country.
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 SOUTH ASIAN JOURNAL OF MANAGEMENT

Inflation Rate
Inflation is measured by the consumer price index (Economic Survey, 1991-1992,
p. 18). Inflation always shows macroeconomic stability of any country. The Laspeyres
formula is generally used in these studies (Schnieder and Frey, 1985; Kok and Ersoy,
2009; Singhania and Gupta, 2011).
Hypothesis 4: Negative inflation rate in the host country will attract more FDI from the
home to home country.
Interest Rate
According to Singhania and Gupta (2011), real interest rates are considered as a proxy
of GDP (%) deflator. Every investor wants to invest where the interest rate is low but
the rate of return is high. If the interest rate is lower than other countries, it will attract
FDI inflows to the country (Clevis and Qamurdan, 2007).
Hypothesis 5: Lower interest rates have positive correlation with FDI inflows in the host
country.
MODEL SPECIFICATION
The empirical work formulates the following equation or economic model which
comprises of the explanatory variables guided by the empirical literature.
The Ordinary least square model that we design to study is:

FDI = p 0 + PflAR + p 2INFLATION + PflNFRA + PflNTR

+ P5OPENNESS + ut - (1)

where, P0 P { /?2 /?3 /?4 and p 5are the coefficient of elasticity’s and after taking the
logarithm model it is converted to this:

IFDI = p 0 + pflMR + pfllNFLATIO N + pflINFRA + pflINTR

+ PflOPENNESS + ut - (2)

In (2) regression equation, l is the logarithm of individual determinant and ut is the

disturbance term or errors. We expected FDI to be positively related to the host country’s
market size, trade openness, infrastructure, and interest rate. However, FDI is expected
to be negatively related to inflation. E-Views 7 is used to estimate the regression
model above. Because these variables are derived from the existing literature, we
selected these variables and applied the ordinary least square regression method.
where,
FDI = Foreign direct investment (BoP US $)
MARKET SIZE = GDP per capita (current US $)

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 TRENDS AND DETERMINANTS OF FOREIGN DIRECT INVESTMENT IN INDIA:
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INFLATION = Inflation (consumer price index)

INFRA = Infrastructure (electricity power consumption)
INTR = Real Interest rate (interest rate (%) GDP deflator)
OPENNESS = Openness (export plus import/GDP)
ut — error term
Since these variables are derived from the literature mentioned above, we have selected
these variables and applied the ordinary least square regression method. There is a
supposition that should be gratified and fulfilled by both variables (dependent and
independent).

RESULTS A N D DISCUSSIONS
VARIANCE
We took the logarithm of the time series data because we needed the small and
concise data for the regression model. With a larger sample or data, the relevant
results could not be obtained, so with the help of log we converted large data into
small. A small variance is requisite for the accurate and coherent outcome of regression
modeling. For example, the time series of FDI is now a natural log of FDI. After taking
the logarithm on FDI, we started using 1FDI.
AUTOCORRELATION
O n the basis of the Durbin Watson Test (DW test), there is no higher correlation in
this time series. The correlation between u.and u (i not equal to j) is zero. In short, the
observations are sampled independently.
where, i and j are two remarkable observations and Cov means covariance. (3) The
equation stipulates that the disturbances u. and u are correlated. For this, we applied
the DW test for checking for serial correlation.
In this study, the normality distribution was checked with the help of descriptive
statistics and the Jarque-Bera test as shown in Table 7. The mean toward median
ratio is 1 or approximately 1 indicating that the data is normally distributed (Gujarati,
2012). Compared to the mean, standard error is low indicating a small coefficient of
variation. The coefficient of kurtosis in all variables is below 3 or near to 3, which
conforms near ordinariness. The Jarque-Bera test also accepted the null hypothesis of
standard distribution of variables.
MULTI-COLLINEARITY
The independent variables were tested to see the correlation coefficients among them
because the independent variables cannot have high collinearity. If a high correlation
is found among these variables, the variable or extent will be exempted so that each

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Table 7: Descriptive Statistics for the Sample (1991-2010)

LFDI LINFLATION LINFRA LIR LMR LOPENNESS
Mean 21.83 1.87 6.01 1.85 1.73 3.59
Median 21.99 1.85 5.96 1.87 1.85 3.56
Maximum 24.49 2.58 6.39 2.24 2.28 4.03
Minimum 18.11 1.30 5.70 1.45 0.05 3.17
Std. Dev. 1.55 0.44 0.19 0.26 0.53 0.27
Skewness -0.57 0.10 0.45 -0.15 -1.70 0.21
Kurtosis 3.36 2.56 2.34 2.76 3.31 2.05
Jarque-Bera 1.08 1.56 0.93 1.21 16.93 0.81

variable can be considered as a separate factor. But, here the multi-collinearity was
not observed because the result of correlation coefficient falls less than 0.8 and 0.9
(see Table 8). This is evident that the correlation between all variables is not very
high and the chances of multi-correlations are low.

Table 8: Correlation Analysis

LINFLATION LINFRA LIR LMR LOPENNESS
LINFLATION 1.00
LINFRA 0.12 1.00
LIR -0.43 -0.35 1.00
LMR 0.12 0.45 -0.36 1.00
LOPENNESS -0.25 0.29 -0.19 0.52 1.00

The empirical result of OLS model (Table 9) depicted that the R-square is 0.92. It
means the regression model is 92% fit for LFDI with specified variables because the
value of the adjusted R-squared is significant (0.89). The multi-collinearity problem
is not observed after taking a lag of one period in FDI and MR, the Durbin Watson
stat is 1.43, which shows no serial correlation.
The estimation regression equation of the relevant determinants of FDI in India is:
FDI = -19.52 + 0.71 (MR) -0.53 (IN FLA TIO N ) + 7.32 (INFRA) + 0.36
(INTRATE) -1.09 (OP)
As shown in Table 9, the market size having positive results and significant at 1%
level which indicates that the market size is positively related to FDI inflows into India
as per the hypothesis 1. In this study, we found that infrastructure also has a positive
effect on FDI inflows. This result is supported from previous studies by Asiedu (2005),
Azam and Lukman (2010) and also indicates a positive relation between FDI inflows
with market size and infrastructure as we have expected in hypothesis 1 and 2. The
inflation rate in India has been found statistically significant with negative sign at 1%

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 TRENDS AND DETERMINANTS OF FOREIGN DIRECT INVESTMENT IN INDIA:
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Table 9: OLS Regression Results

Variable C o efficien t T- Statistic Prob.
C -1 9 .5 2 -3 .8 1 0 .0 0

MR 0.71 2.35 0.03

OPENNESS -1 .0 9 -0.89 0.03'
INFRA 7.32 -1 .7 1 0 .1 1 **
IR 0.36 10.07 0 .0 0

INFLA TIO N -0 .5 3 0.63 0 ,5 4 ***

R-squared 0.92 Mean dependent var 21.83

A djusted R-squared 0.89 S.D. dependent var 1.55
SE of regression 0.5 Akaike info criterion 1.72
Sum squared resid 3.04 Schwarz criterion 2 .0 2

Log likelihood -9 .5 5 H annan-Q uinn criter. 1.76

F-statistic 30.12 Durbin-Watson stat 1.43
Prob (F-statistic) 0 .0 0

Note: * indicates 1%, ** indicates 5% and *** indicates 10% level of significance.

level of significance as per hypothesis 4- The interest rate was found to be significant
with the expected positive sign at the 5% level of significance so that we can say our
hypothesis 5 has been proved. Trade openness has a negative sign, which was unexpected
in the hypothesis 3, but it is also significant at the 10% level of significance. Azam and
Lukman (2010) also found a negative relationship between trade openness and FDI
inflows. It does not represent that variables have no effect on the FDI inflows; in fact,
they are in the same way important determinants of FDI inflows as other all variables
had an equal importance to the inflow of FDI in India, but infrastructure and market
size are clearly more important than other variables.

CONCLUSIONS AND POLICY IMPLICATIONS

This paper reveals the FDI policy (Pre and post revised), trends and determinants of FDI
in India for the period 1991-2010. After testing for the time series properties, results
from the analysis showed that the market size and infrastructure are the most crucial
variables in making India attractive to foreign investors. The findings also confirm
that foreign investors want a better and large market place for investment. The results
of this study are consistent with those observed in the literature. The findings suggest
that in addition to providing incentives and financial investment, the government
must ensure that the work force, human capital, and the science and technology
sectors remain competitive. The results of the analyses can be summarized as follows:
(i) there exists a positive relationship between market size and FDI inflows to India;
(ii) openness has a negative impact on FDI flows; (iii) high inflation rate has a negative
effect on FDI inflows to India; (iv) infrastructure attracts FDI inflows to India; (v)
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higher interest rate has a positive relation with FDI inflows in India. The main limitation
of this study comes from the regression model equation in terms of trend and intercept.
Because we used the time series data that is mostly used for demonstrating the effect
of slow economy (GDP growth rate decline); other distortions are bound to be the
part of the present study. These distortions can lead to additional explanations of the
relationship between FDI inflows and other independent variables. The second
limitation of the study is that we have tried to find out the main relevant determinants
in India, but as it varies country wise, the list cannot be comprehensive. It is crucial to
locate the accountability of the modified independent variables and those variables
that are unexplained in the present study. The third and last limitation of this study is
that we used FDI inflow as a dependent variable because there are very few studies on
FDI outflows.

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